What To Know Trading Forex in Retirement Account?

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Forex is the largest and most liquid market in the world. Because it is traded in so many countries and in such a diverse number of currencies, there are always many trading and investment opportunities.

In this guide, we will explore how you can trade in forex from an IRA and what are the benefits and potential risks associated with that.

If you have been wondering if it would be possible to trade forex in an IRA, the answer is Yes.

Individuals can trade forex in an IRA by opening a self-directed IRA with an investment company that allows the trading of foreign currencies.

However, there are some rules that self-directed IRAs have to follow, but trading forex is generally not prohibited.

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Once the account has been set up, trades can be made through an individual's brokerage platform by opening a foreign currency trading account with that broker and linking it to the self-directed IRA.

Should you trade forex in a retirement account?

Forex can be a great way to diversify your retirement account since you buy the currency of a country with the intention to profit from a change in its value.

Depending on how you approach the forex market you may make it a valuable investment tool, or speculative trading medium you buy and sell assets quickly.

Here are the main benefits of trading Forex.

1. You don't need a big initial capital

You can start trading forex with a fraction of the investment as you would for stocks and mutual funds.

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For example, when you are buying stocks you have to buy in blocks like $500 or $1,000 at a time. Because there are fixed brokerage fees and commissions you will pay per trade.

On the other hand, you can open positions in forex as many times as you want without any of these limitations. Every position is charged a spread according to the size of your position.

2. No commissions

Most forex brokers do not charge commissions. Instead, they make their money from the spread, which is the difference between the buy and sell prices.

This is a particular advantage over stocks and mutual funds, where commissions can quickly deplete your trading account.

That said, the spread can be varying depending on a few factors, such as the broker, currency pair, and time of day.

Therefore, it is important to work with a good broker that has low spreads and charges no commissions.

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3. You can go both long & short

In the forex market, you can open long and short positions. This is a particularly big advantage of trading the forex market.

Because trading stocks in an IRA you cannot go short. To go short you'd have to buy an inverse ETF which further complicates things. Forex market gives you the ability to go both long & short.

That said, you have to check with your brokerage if there are no restrictions applied for this trading from an IRA.

4. You can use the leverage (margin trading)

Leverage is the ability to trade using a margin that is larger than your capital. It's expressed in the ratio of how much you can borrow for every dollar of capital at risk.

The leverage is “the double-edged sword.” The more leverage, the higher your potential gains on each trade as well as losses if things go wrong.

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Since the value change in forex pairs not much, leverage allows traders to control large positions with a relatively small capital outlay.

But there's also increased risk involved for those who don't know what they're doing.

If you trade with a large amount of capital you will not need leverage at all since a large amount of capital will already offer you meaningful changes in your trading account.

Which brokers you can work with?

Many retirees already have accounts with Fidelity Investments, TD Ameritrade, or Charles Schwab and can find comfortable trading currencies with those brokers.

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The process of opening a self-directed IRA is similar to opening an account with any other investment company, and it does not require the transfer of retirement funds from another provider.

The only difference is that you are able to trade forex inside your account instead of investing exclusively in stocks or bonds.

Brokers who specialize in forex trading like Interactive Brokers and Forex.com are also a good choice for retirees looking to trade with leverage.

However, you will most likely not utilize your IRA's tax benefits when trading forex with those brokers.

Because you have to deposit cash to these brokers in order to trade with them which takes away the advantage of trading directly within an IRA.

What are the restrictions on trading forex in an IRA?

Trading forex in a retirement account is not prohibited by the IRS. It just has some caveats and “unsavory” consequences that should be taken into consideration before making your decision.

The big disadvantage to trading in your retirement account is that most brokerages will not let you withdraw money from your account without penalty until age 59 ½ or older.

This means if you need access to funds early, then this type of account may not be right for you especially since many retirees don't want to take on any additional risk when they're drawing income from their savings already.

Another disadvantage is capital gains taxes. Retirement assets are taxed at lower rates than other investment vehicles like stocks and mutual funds; however, selling investments within your IRA can result in capital gains taxes being applied to the transaction.

The final disadvantage is that most brokers will limit your trading activity on margin accounts.

You'll have fixed limits for borrowing money and you can't trade as much or use complex strategies like short selling, hedging, leveraged investing, or options.

You can only trade through regulated forex brokers and not allowed to trade with offshore brokers on unregulated platforms. 

How to start trading forex in an IRA?

There are important points you should pay attention to if you have never traded forex before.

1. Learn Forex terminology

You may have earlier trading experience in other markets. However, Forex trading is an entirely different animal.

Therefore, before starting to trade Forex from a retirement account it is important that you become familiar with some of the terms used in Forex trading.

This way, when making decisions about what trades to place or how much money to invest, you are able to make an educated decision rather than relying solely on emotions.

Terms like “spread” (the difference between the bid price and ask prices), pip(s) (a unit of change in currency exchange rates), lot sizes (size of position per contract traded).

2. Start with a demo account

A lot of people make the mistake of starting Forex trading by depositing money into a live account. This can be dangerous because you do not know what to expect and how the market behaves.

What traders should start with is a demo account instead, so they can “practice” while still having the opportunity to learn how currencies behave and the trading platforms function.

In demo accounts, trading platforms usually grant access to all the features on offer in terms of analyzing, executing trades, without risking real money.

Trade on a demo account until you are comfortable enough with your strategy before putting real money on the line.

You may be thinking you know what you are doing, and you are well enough to trade with real money. Then start with a small amount of money and trade with it.

For instance, start by trading $100 or risking no more than a few dollars per trade. It will be enough to test your strategy with real money while risking only a small amount.

If you are not sure what to trade, then start by trading with the currency that is closest to your home country because it would be easier for you to follow and understand how this one performs in comparison with other currencies in general.

Once you have mastered understanding forex from a retirement account, move onto another currency and repeat the process.

Trade currencies according to their market capitalization. Smaller exchanges often lack liquidity which can lead to volatile price swings among smaller capitalized assets like countries or stocks.

On these markets, traders may need more time than usual before they see an opportunity worth taking advantage of when there is no clear pricing direction from buyers or sellers available at any given moment.

3. Know how to size a position

Most traders risk only about 1 – 2% of their account size. I am not even talking about the percentage of your entire retirement account. But rather the percentage of the tradable sum you have allocated for forex trading.

It is best to keep the size of the trading account only a small percentage of the retirement account.

As the best practice, your forex trading account shouldn't exceed more than 20% of your retirement account. Because Forex trading is a risky business, and you have no luxury to take large risks on the money you have saved your entire life.

4. Utilize calculators

Should you have to use forex calculators? The answer is you don't have to.

However, Forex calculations are more complicated than other markets due to the fact that there are two different currencies involved.

If you have never traded forex before, it may look complicated to calculate how much you risk per trade.

Therefore, forex calculators are an invaluable tool calculating position size or lot size, stop loss and take profit points and money management for trading.

If you are not comfortable with using a calculator, then you can use a regular calculator, pen, and paper but I don't recommend this practice since you can miscalculate the risk of the position.

The calculator takes into account a number of factors such as pip value, margin requirements, currency pairs (exchange rates), lot size, and leverage to output an accurate calculation based on how much you want to risk with each trade.

5. Research carefully

Do not make the mistake of trading forex without understanding what it is or doing some serious due diligence first. Be patient and carefully research the currency pairs to trade.

Researching provides information on currency pair performance and changes in exchange rates which can impact your trade decisions and profitability.

6. Trade major pairs only

Avoid trading currencies from small countries that are not major players in the forex market. Most of these pairs are either not liquid enough or too risky to trade due to political and economic instabilities.

Forex is generally used for trading and speculative purposes, not for hedging.

Therefore, it is important to avoid the risk of trading a currency pair that might not have enough liquidity, which could lead to an unfavorable trade.

Instead, focus your attention exclusively on major pairs such as EUR/USD (foremost traded in the market), GBP/USD, USD/JPY, etc., since they are liquid and less risky than smaller currencies from emerging markets with volatile economies.

One exception would be, if you are a South African citizen and know the country's economy and South African Rand, then go for Rand pairs. Otherwise, don't trade currencies you don't know at all.

Every currency pair has different characteristics. You should also analyze the market's historical behavior in order to make better decisions.

7. Trade only in small position sizes

You may have traded in the stock market or other markets that make you feel confident. But Forex market is entirely different and has very different dynamics.

You will make mistakes, but don't let those be costly ones.

Therefore, only trade small position sizes, especially at the beginning when you are warming up with the forex market and learning the trading platform you are using.

If you don't know how to size a position then it is time to learn that before everything else. Because risk management is the #1 denominator of how much you will last in this game.

8. Make sure what leverage you are using

Make sure that you know what leverage is offered at Forex brokers before signing up with them.

In Forex trading, a lot of time leverage is adjusted at the account level rather than per trade basis.

Therefore, before opening a position know how much leverage your account is using.

Leverage is usually set once you have created the account.

However, you should be able to adjust it in your trading platform yourself, or contacting the support department of your broker.

9. Stay away from forex bots & robots

There is a lot of hype around the automated trading programs or also called “trading bots”. These are programs that can trade by themselves, without input from the trader.

However, trading bots are not a good idea for most people since they automate trades and this can lead to investing in something you don't know much about.

Most of these bots use complicated strategies, and there is not enough proof that they can be profitable over the long run. 

For those who want more control over their retirement account investment decisions (like retirees), I recommend staying completely away from the Forex Robot Advisors and trade manually by themselves.

10. Don't day trade

I can never emphasize enough the importance of this one. Do not day trade the forex market.

Although the Forex market is the most suitable, the liquid market offers a lot of day trading opportunities, you don't want want to do it.

The reason behind, day trading is stressful. You don't want to have another full-time job when you are enjoying your retirement years.

Don't day trade with retirement funds! Trade long-term hold positions for maximum profit potential.

In the Forex market, if you don't close a position but leave it open for the next day, there may be charges (positive and negative) for the positions that are open.

It is generally sourced due to the difference in the interest rates of different central banks.

If you plan to carry trades, you should beware how much you can earn, or pay for the trade you carry to the next day.

11. Don't overtrade

It is important not to trade too often so that your trades are more profitable over time.

A lot of people fall into the trap of trading too often because they have more time on their hands.

However, over-trading will not only occur more trades but also more commission fees.

Plus, it will lead to higher taxes because you would have a lot of transactions in your account and these can trigger high-frequency trading rules that may apply to short-term capital gains.

12. Diversify your portfolio

The key is diversifying your portfolio, which means spreading your investments into other markets in addition to FX.

You might want to consider investing some money in ETFs that invest in international stocks or bonds.

Conclusion

Please note that Forex trading carries the risk of loss, so do not put any more than an amount you can afford to lose in order to protect your retirement funds.

Forex trading should be treated as an investment and not a get-rich-quick scheme.

It is a difficult, but rewarding market. The most successful traders are the ones who study it and take time to stay updated on all of its dynamics.

Finally, diversifying risk across different currency pairs will help hedge currency risks associated with overexposure to any single country's economy.